The world’s most successful investor didn’t get to where he is today without a deep understanding of how the market works.
According to him, the most important rule of the market is not to lose money. The second rule only reinforces the first.
In this rule you can find a timeless wisdom of the market…
If you lose 10% on a stock (a drop in $100 to $90), then you need to make a profit of 11% (a profit of $90 to $100) to get back what you lost.
To recover a 20% loss, you must make a 25% profit. To recover a 50% loss, you must double your money.
As they say in motorsport, ‘To finish first, you have to finish first.’
So don’t waste money. But how not to lose money in the market?
Well, Buffett follows the timeless wisdom of his mentor, Benjamin Graham, who taught him the importance of “margin of safety.”
This is what he said…
“The three most important words in investing are margin of safety.”
This is the idea of buying shares at a price lower than their intrinsic value. It is the cornerstone of value investing.
Here is an article on how to find the intrinsic value of a stock.
By buying stocks at a discount to their intrinsic value, you’ll avoid filling your portfolio with overvalued stocks.
Instead, your portfolio will have undervalued stocks that should provide good downside protection. These are usually called value stocks.
But to do this, you need to find the value of a business, that is, its intrinsic value.
In fact, Buffett has said that the only two things you need to know about making money in stocks are how to value a business and how to think about stock prices.
But what about stocks in a market crash? Should you buy more? Sell? Or just wait?
What does Buffett have to say?
Here is a quote from Buffett that is quite prescient…
“If you’re not thinking about holding a stock for 10 years, don’t even think about holding it for 10 minutes.”
This is why Buffett is saying, if you’re in the market for short-term trading, then stick with it. Do not think about becoming an investor. A true investor is a long-term investor.
Here’s another quote that is classic Buffett…
“Just buy something you’d be perfectly happy to have if the market closed for 10 years.”
To learn more about this, read the Equitymaster article: 10 Rules for Successful Long-Term Investing.
Market crashes are inevitable. they will happen Like the fall in the market now. So get ready for them.
During these periods of decline, look for ways to capitalize on opportunities in the market. Invest in shares of your favorite companies that are trading cheap.
“The next few years will occasionally generate significant market declines, even panics, that will affect virtually all stocks. No one can tell you when these traumas will occur.”
And that is absolutely correct. No one can predict market crashes. We can learn from them. We can be prepared for them. We can take advantage of them.
Buffett uses market corrections like the current one to aggressively buy stocks. He sees them as ideal buying opportunities. You also should.
Stock markets swing wildly on the news. They go up and down depending on the feeling. It is important not to get caught up in the market madness. Instead, stick to your task and always stay rational.
But what if you lose money?
Losing money in the stock markets is natural. Everyone has to deal with losses sometimes. There is no way around them. Therefore, you must know how to handle market losses.
A good way to do this is to clean out your portfolio. Keep only fundamentally sound stocks and get rid of all junk stocks.
Use the money raised from the sale of poor quality stocks to buy more good quality stocks.
Here’s what Buffett has to say…
“If you’re on a chronically leaking boat, the energy spent changing boats is likely to be more productive than the energy spent fixing leaks.”
Don’t throw more money at stocks that are doing poorly. If the company’s fundamentals aren’t improving, it’s best to sell and get out of the stock.
This is a difficult decision to make. If it will involve some pain of losing money in the short term.
But accepting this loss will prove to be a smart decision. Not only will you avoid further losses, but you’ll also make more profits in the future if you buy more fundamentally sound stocks.
You can use the Equitymaster Stock Screener to find fundamentally sound stocks.
You can get started right away with our Warren Buffett Stocks Screener.
(This article is syndicated from Equitymaster.com)